Samson v. Spencer (In re Spencer), 2023 WL 2563751 (Bankr. S.D. Ill. 3/17/23)

The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), analyzing a recent decision of interest:

SUMMARY

The United States Bankruptcy Court for the Southern District of Illinois (the Court) recently ruled that a chapter 7 trustee could uses the strong arm powers conferred upon him by 11 U.S.C. § 544(b)(1) to avoid a disclaimed inheritance as a fraudulent transfer pursuant to the Federal Debt Collection Practices Act (FDCPA or “the Act”). Samson v. Spencer (In re Spencer), 2023 WL 2563751 (Bankr. S.D. Ill. 3/17/23). 

To view the opinion, click here.

FACTS

            The chapter 7 debtor’s parents created an irrevocable trust in 1995 which provided that upon the last grantor’s death, the trust residue would be divided among their four children, one of which was the debtor.  The last parent died in January 2019, at which time the trust had $1.5 million to distribute. In May 2019 the debtor disclaimed his interest, which caused the trust to distribute his portion to his adult children when possible.  When the last parent died, the debtor owed the Internal Revenue Service a partially secured and partially unsecured debt.  After the debtor filed his chapter 7 in July 2020, the IRS filed a partially secured and partially priority unsecured claim, consistent with the debtor’s schedules.

            In June 2022 chapter 7 trustee Donald Samson (the Trustee) filed an adversary complaint to avoid the disclaimer of the inheritance as a fraudulent transfer under 11 U.S.C. § 544(b) and 28 U.S.C. §§ 3304(a)(1) and 3304(b)(1)(A) (the latter found in the Act) and to recover the funds for the estate.  The targeted defendants were the debtor’s adult children who had received distributions and the trustee of the trust, because some of the funds remained undistributed (presumably because some of the children were not yet adults or could not be located).     

            The defendants filed a motion to dismiss under Fed. R. Civ. Pro. 12(b)(6), asserting that the complaint failed to state a claim for relief.  The Court denied the motion, concluding that the Trustee could utilize the FDCPA as “applicable law” under § 544(b)(1), that the FDCPA preempted state law which would deem the disclaimer related back to the last death such that the debtor never had a property interest in the funds, and that the disclaimer was a “transfer” of the debtor’s property interest.

REASONING

            The FDCPA provides the “exclusive civil procedures for the United States” to recover debt.  28 U.S.C. § 3001(a)(1).  It includes provisions for the avoidance of actual fraud and constructive fraudulent transfers at §§ 3301-3308.  A constructive fraudulent transfer can be avoided if the transferor receives less than reasonably equivalent value for the property transferred.  Section 544(b) allows the Trustee to step into the shoes of the IRS to “avoid any transfer of an interest of the debtor in property…that is voidable under applicable law by a creditor holding an unsecured claim…” The Court recognized a split in authority on whether the FDCPA was “applicable law,” with no controlling precedent in the Seventh Circuit.  However, it followed a significant majority of courts who read “applicable law” broadly, not just limited to state law, because of Supreme Court authority which had interpreted the term “applicable nonbankruptcy law” to include any federal statutes.  Moreover, if Congress had wanted to limit the phrase, it could have done so.  The minority opposition largely relied on a provision in § 3003(c)(1) of the Act, which states it “shall not be construed to supersede or modify the operation of title 11.”  The Court rejected that view because allowing a Trustee to use the FDCPA fraudulent transfer sections neither modified nor superseded Title 11; instead it implemented a remedy provided by the Bankruptcy Code.

            Next, the Court addressed whether at the time the debtor disclaimed the inheritance, he had a property right.  It noted that under Illinois law, a disclaimer relates back to the date of the last death which triggered the right to receive a distribution “for all purposes.”  If that law prevailed – as is common because generally property rights are as defined by state law – then at the time of the disclaimer in May 2019, the debtor had no property to transfer because the relation-back date was January 2019.  However, the Court noted two authorities which limited the use of state law to determine property interests, Jones v Atchison (In re Atchison), 925 F. 3d 209 (7th Cir. 1991) and Barnhill v Johnson, 503 U.S. 393, 398 (1992).  These authorities acknowledged that state law defined property interests “absent a federal provision to the contrary.” Atchison, 925 F. 3d at 210.  The Court determined that the FDCPA was a “federal provision to the contrary.”  In addition, the FDCPA itself had an express preemption clause which would apply if state law was in conflict with the Act. Here, the application of the Illinois relation-back rule would be in conflict with the FDCPA sections which would allow the Trustee to recover the disclaimed inheritance.

            Lastly, the Court was tasked with determining whether the disclaimer was a “transfer” of an interest in “property” under the FDCPA.  The Court looked to the broad definition of “transfer” in § 3301(6), “every mode, direct or indirect, absolute or conditional, voluntary or involuntary, of disposing of or parting with an asset or an interest in as asset….”  It also noted that “property” was broadly defined to include “any present or future interest, whether legal or equitable, in real, personal…or mixed property, tangible or intangible, vested or contingent, wherever located and however held….”  § 3002(12). Those definitions caused the Court to conclude the debtor held a “present…or future interest” in “property held in trust” which he parted with by executing the disclaimer.  This made the disclaimer qualify as a transfer of an interest in property, consistent with the fraudulent transfer provisions of the FDCPA.  Accordingly, the Trustee could pursue those claims in the bankruptcy proceeding.

AUTHOR’S COMMENTS

            A couple other things are important to note from this opinion, which is thorough and reads more like an appellate court writing on legal issues than a typical trial court – i.e., I highly recommend that interested attorneys read it.  First, while acknowledging that the issue is of first impression, the Court did not see permitting a trustee to proceed under the FDCPA as a departure from established law.  Rather, the Court concluded that trustees rarely invoke the Act because they are not aware of its avoidance provisions.  Second, the opinion notes similarities to a ruling in a nonbankruptcy Ninth Circuit case, United States Small Business Administration v Bensal, 835 F. 3d 992 (9th Cir. 2017).In Bensal the Ninth Circuit refused to honor a disclaimer under California law on the grounds that it was preempted by the FDCPA.  There, the SBA had obtained a judgment against Bensal, who subsequently disclaimed an inheritance from his father’s trust and asserted that the relation back element of California’s law pertaining to disclaimers meant he had no interest to recover as a fraudulent transfer under the Act when he disclaimed.  The reasoning of the Ninth Circuit in rejecting this state law protection was virtually identical to the Court’s ruling here.  I expect trustees in the Ninth Circuit will swiftly become aware of this Illinois bankruptcy court opinion and will be using the FDCPA, where applicable, in fraudulent transfer actions in the future.

This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. CA., Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.